Rubber duck investing

In Switzerland, UBS Wealth Management is telling global investors to go overweight US equities.

Summary: Global investment group UBS Wealth Management is urging its investors to go overweight US equities. The investment bank believes market hysteria over the Fed’s suggested taper in quantitative easing is short term and misplaced, and that the US economy will soon be robust enough to handle a cutback in monetary stimulus.
Key take-out: UBS says non-resident clients should boost US equities to 25% of their total portfolio.
Key beneficiaries: General investors. Category: Portfolio management.

Alexander Friedman, UBS Wealth Management’s global chief investment officer, and his comrade in arms, Mark Haefele, the unit’s head of investments, see markets as rubber ducks floating in a bathtub.

I rather like that. It’s a simple but effective image. The water flowing from the tap represents central-bank liquidity, the plug represents the fundamental strength of an economy, and the ducks bobbing about the rising or falling water signify market performance.

In other words, rising markets these days are predicated on both a credible central bank supplying liquidity and a real-world economy chugging underneath. For that reason, the two executives are intently urging their clients, families from around the world who have parked $US1.9 trillion at UBS Wealth Management, to go overweight US equities. “When we look at where the plug is strongest,” says Friedman, “it’s the US.”
Graph for Rubber duck investing

Alexander Friedman (left) and Marke Haefele.

That’s significant. Foreigners’ net investments in US markets last year hit $US25.18 trillion, $US4.42 trillion more than Americans collectively invested overseas, underscoring just how important foreign liquidity has become to our domestic markets and why it’s always wise to know how foreign institutions view the US. For that reason, I head down the Bahnhofstrasse in Zurich and bang on UBS’ door. Barron’s profiled Friedman and Haefele earlier in the year, when the sequester was causing agita, and I’m curious to see if their thinking has changed.

It has. They’ve become noticeably more bullish on the US. But first a word about UBS’ global clients. The megabank in Switzerland is, of course, a haven for wealthy clients in less-stable countries across the globe, and these hyperconservative clients keep about 30% of their UBS portfolio in cash, which is “way too much,” says Haefele.

In contrast, UBS’ moderate-risk model portfolio in dollars for a nonresident outside of the US is currently 19% in fixed income, 49% in equities, and 9% in cash. With cash and government bonds providing a negative yield, rate risk significant and on the rise, and gold an illusory haven, the real risk, says Friedman, is clients “hiding in ‘safe’ assets that aren’t actually safe.”

So for the past year, they’ve been making the case for US equities, but do so now with increased vigour and an interesting take on the news. Even heavyweights like Paul Volcker and Alan Greenspan have publicly joined the chorus of Fed-bashers after the taper announcement. In contrast, these ex-pat Americans in Zurich – Friedman was formerly the CFO of the Bill and Melinda Gates Foundation – argue the freak-out over the Fed’s suggested taper is short term and misplaced. They liken the overreaction to telling a junkie that, in order to get healthy, “you have to get off the drugs.” Intellectually, junkies know what you’re saying is right, but they aren’t used to it physically, and just the idea of withdrawal fills them with dread.

Beyond the inevitable short-term dip and turmoil that will come from market-timing traders repositioning around a taper, what the news really signifies is that the Fed is carefully monitoring the housing market and spreads, and coming to the conclusion that the US economy will soon be robust enough to handle a cutback in monetary stimulus. “This is not a bad thing. It’s a good thing,” says Friedman.

Furthermore, “not fighting the Fed has been a successful investment strategy,” and the Fed – a credible lender of last resort – has publicly stated that if there is any deterioration in the US economy, they’ll reverse course on the taper. So, most importantly for long-term investors, the Fed’s growing confidence is really “great news about where the US economy will be for the next two to four years.”

Their call now is that nonresident clients should boost US equities to 25% of a total portfolio, 5% overweight the benchmark, because the Standard & Poor’s 500, including buybacks, is yielding around 5%, an attractive return in a low-yield environment. But dividend-yielding stocks have been the rage for years and are expensive, I counter. True, they say, but their focus is on companies that are “shareholder friendly, with high cash flow, and return that cash to shareholders.”

Firms with a history of share buybacks are, in particular, a “good way to play” the US. They’re also hot on companies with a minimum 20% of sales in emerging markets, and small- and mid-cap US stocks, those firms that should get fillips and become takeover candidates as the US economy strengthens.

On the fixed-income side, the UBS twosome urge overseas clients to cut high-grade dollar-denominated government bonds and blue-chip corporate bonds from 16% to 2%. The overriding goal of all this shuffling is to get their global clients out of “safe” assets like cash and government securities and into equities.

“There is only one free lunch in investing,” says Friedman, “and that is diversification. That is an immutable truth [and] not one to be disregarded.”

If they are successful, and just a portion of their global clients’ 30% cash holding moves into US equities, America’s rubber duck is bound to bob higher.

This article has been reproduced with permission from Barron's.

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